EUR 850.00 For Business Accounts Only

Morningstar | HPE's Fiscal 2018 Results in 7% Growth but We Expect Long-Term Headwinds; Maintaining $15 FVE

No-moat Hewlett Packard Enterprise's fiscal 2018 resulted in revenue growth of 7% year over year as the pivot in the company’s focus from volume to value-add sales is paying off. Driven by robust growth across its intelligent edge, compute, and storage product families, HPE exceeded top line consensus expectations. Although we like HPE's strategic shift, combined with a strong IT infrastructure spending environment, we are maintaining our fair value estimate of $15 per share due to concerns that margins will have limited long-term expansion opportunities due to HPE's large existing presence within the commodity-based compute and storage markets. With shares trading in 3-star territory, we advise investors to maintain their positions.

We believe that HPE's quarterly results are indicative of enterprises requiring an increasing amount of hardware and software solutions outside of the core data center. Data is proliferating rapidly, enterprises are deploying more cloud-based solutions, and computing is moving closer to the end user, or edge. In the quarter, HPE's intelligent edge division grew 17% year over year to $814 million, but its operating margin declined to 10% of segment sales as HPE increased its sales and R&D expenditures to invest in this rapidly growing segment. The hybrid IT division (mainly compute, storage, and services) grew 5% to $6.4 billion compared with the prior year, and its operating profit increased to $764 million (12% margin) as HPE sold higher-margin hyperconverged infrastructure and high-performance compute products with attached services. HPE's financial services' revenue declined by 7% year over year to $939 million, while its operating profit slightly increased to $73 million (8% margin) due to a large onetime lease buyout deal. HPE posted consolidated operating profit of $684 million, but a net loss of $757 million in the quarter, largely driven by U.S. tax reform.

HPE's fiscal 2019 EPS guidance was reiterated by management as initially stated at an analyst day in October, and we kept our existing expectations intact. We expect marginal top line and operating income growth in fiscal 2019 as HPE continues to shift away from commoditized products and toward selling nascent technologies for cloud-based IT environments. In our view, HPE will continue its positive momentum in growing free cash flow and returning value to shareholders in fiscal 2019. However, long-term, we expect tough competition from networking infrastructure players, that do not have large presences in the price sensitive compute market, to make HPE's success rate with nascent networking technologies challenging.

In November, HPE announced a definitive agreement to purchase BlueData, a firm that provides big data and machine learning workloads on containers, for an undisclosed amount. BlueData will expand upon HPE's hybrid-cloud strategy by opening up cross-selling opportunities with artificial intelligence, machine learning, and analytics. We believe these value-added sales will help HPE's migration from being a commodity-based compute and storage player. Additionally, management commented that hyperscale cloud providers are now less than 10% of the compute portfolio (from 20% a couple years prior). We believe the focus on higher margin products was a wise decision in order to escape the threat of commodity white-box hardware and we note that HPE was not selling services to the large cloud providers.